Schwarzenegger and California Legislators Reach Tentative Budget Deal

California legislative leaders and Governor Arnold Schwarzenegger have reached a tentative deal to close the state's projected $40bn (£28.1bn) budget gap on the backs of virtually every Californian, from taxpayers to state workers to welfare recipients, according to sources close to the negotiations.

The plan includes $15.8bn in spending cuts, $14.3bn in taxes and $10.9bn in borrowing, according to a budget outline obtained by the Sacramento Bee newspaper. The state also anticipates billions in federal stimulus money, which would reduce each component of the solution if California receives more than $9.2bn.

Staff members are still drafting bills, but sources said the legislature plans to vote tomorrow. It remained unclear whether leaders could corral the votes necessary for approval.

Under proposed spending cuts, state workers would lose two bank holidays and face ongoing furloughs through June 2010, while prisons would face a 10% reduction to their medical budget. Welfare recipients and low-income disabled, blind and elderly individuals would not receive cost-of-living increases.

The deal discussed by legislators would not significantly reduce projected programme cuts by schools over the next 17 months, more than $5bn in real cuts, but it could affect what programmes are chopped, said Kevin Gordon, a veteran education lobbyist.

The plan would raise sales taxes by 1 cent on the dollar and place a 2.5% surcharge on income taxes across the board – 5% if federal stimulus money does not reach $9.2bn. Drivers would pay more through a 12-cents-per-gallon fuel hike and an increase in the vehicle licence fee from the current 0.65% of vehicle value to 1.15%. The proposal also would cut the state's dependent credit from $309 down to $99.

As a trade-off for new taxes, Republicans demanded a limit on future state spending. Under the tentative agreement, the restriction would require the state to place money into a rainy-day fund after reaching a limit determined by state revenues over a 10-year period.

Voters would have to approve the spending limit, likely in a special election later this year, and it is particularly controversial among education groups who constantly seek more state money for schools. Concerned that the state's powerful teachers' union would try to kill the spending restriction at the ballot, budget negotiators included a provision that would extend the major new taxes by one to three years if the spending cap passes.

The vast majority of legislative Republicans have signed pledges not to vote for new taxes. California senate Republican leader Dave Cogdill said he could not guarantee votes, but told his members that the deal is as good as they're going to get.

"I've negotiated it to the point where I think it doesn't get any better," he said today, emerging from a private GOP caucus. "We're waiting to see all the language and all of that so I'm not ready to commit who the votes will be at this point."

The Republican governor himself pledged opposition to taxes in 2006, but he has since said he believes the state's problem is not solely overspending. For him, backing an increase in the state's vehicle-licence fee is a symbolic reversal after he famously slashed the same fee upon entering office.

Schwarzenegger already has unilaterally ordered two furlough days per month, shutting down most of state government on the first and third Fridays of each month. The budget deal allows flexibility to soften furloughs should public employee unions reach agreement with the Schwarzenegger administration.

Schwarzenegger threatened this week to send 20,000 layoff notices to state employees, on top of the other cuts, if lawmakers do not commit to a budget deal by then. Asked if large-scale layoffs could be averted, senate President Pro Tem Darrell Steinberg, a Democrat from Sacramento, said at the Sacramento Press Club, "Things are moving in a positive direction."

While businesses were unable to obtain rollbacks in labour provisions related to meal breaks and overtime pay, they would score victories on tax code changes if the deal is approved. A shift in how the state calculates each company's sales could save businesses $650m in state taxes. Businesses also would receive a $3,000 tax credit per each new employee hire.

Education cuts would reduce funding for dozens of programmes targeting specific purposes, such as summer school or assisting gifted students. Special education and a programme for English learners would be exempted, and penalties would be reduced for districts that raise class sizes, Gordon said.

Schwarzenegger has dropped a proposal to eliminate a week of instruction next year in California's public schools, but the issue may be re-evaluated this spring.

State leaders are counting on voters approving a plan to borrow $5bn this year against future California Lottery revenues. The state would obtain another $5.5bn in costly short-term loans with no defined way to pay it back by 2011. California would first use federal stimulus money to eliminate that borrowing.

California would then use federal stimulus dollars to build a reserve. If the state obtains more than $9.2bn in federal aid, it would cut the income tax hike in half and eliminate $950m in planned spending cuts to several programmes, including in-home care and the medical assistance programme Medi-Cal.

Voters would also have to approve the state shifting existing special funds for mental-health services (Proposition 63) and early childhood development (Proposition 10) to help balance the budget.

Under the tentative deal, Schwarzenegger would score wins on changes to stimulate construction. The proposal gives the state unlimited authority to use public-private partnerships for state transportation projects through 2017. It also authorises a limited number of projects to combine the design and construction phases, a change opposed by the public engineers' union. And the proposal exempts eight major state highway projects from environmental review while allowing for an expedited permitting process.